The Asian Development Bank’s Engagement with Middle-Income Countries, Linked Document 3

DISTINGUISHING MIDDLE-INCOME COUNTRIES FROM LOW-INCOME AND

HIGH-INCOME COUNTRIES

1. Indicators developed by the global development community and think-tanks show that middle-
income countries (MICs) have the potential to reach performance levels that are at par with those of
high-income countries (HICs) by improving their physical infrastructure and logistics, education and
health care, and other social infrastructure; institutional mechanisms; governance and markets;
financial systems and enterprises; and physical environment, among others.

2. Competitiveness. Competitiveness can be conceptualized as a function of the set of institutions,

policies, and factors that determine the total factor productivity level in a country.1 The global
competitiveness index (GCI) aggregates measures for the following: (i) macroeconomic environment,
institutions, infrastructure, health, and basic education, which are the prime concerns of factor-driven
economies;2 (ii) higher education and skills, goods market efficiency, labor market efficiency, financial
market development, market size, and technological readiness, which are of prime importance in
driving economic efficiency;3 and (iii) business sophistication and technological innovation aimed at
increasing production efficiency, which are important to innovation-driven economies.4 The
methodology for computing the GCI score recognizes that countries do not abandon any specific
development area, even though it may not be accorded the same priority as before. 5 The GCI provides a
glimpse of the types of issues likely to be increasingly of interest in the coming years to a particular
MIC.

3. Subject to reservations on the choice of variables that define GCI, and the measurement-related
issues associated with the indicators, Figure 1 shows that the Organisation for Economic Co-operation
and Development (OECD) countries generally have a higher score than upper middle-income countries
(UMICs), which in turn have a higher score than lower middle-income countries (LMICs).

1
World Economic Forum. 2015. The Global Competitiveness Report 2015–2016. Geneva.
2
The macroeconomic environment is important for business, as borne by the harm that macroeconomic disarray can bring
about. Institutions are the legal and administration framework within which individuals, firms, and governments interact.
Infrastructure is critical for ensuring the effective functioning of an economy. Health impinges directly upon productivity and
basic education provides basic skills.
3
Higher education and training enable economies to move up the value chain. Goods market efficiency comes from healthy
market competition (both foreign and domestic). Labor market efficiency comes from allocating workers to the most effective
use and incentivizing them. Financial market development efficiently allocates national savings and cross-border (inward)
capital flows. Technological readiness is a measure of the agility with which an economy adopts existing technologies to
enhance the productivity of its industries. Market size (both foreign and domestic) influences the scale of operation.
4
Business sophistication refers to business networks and the quality of individual firms’ operations and strategies. Technological
innovation refers to improvements in products, processes, and organizational methods aimed at increasing production
efficiency.
5
For instance, the methodology recognizes that (i) basic requirements of macroeconomic stability, good institutions and
infrastructure, and basic education and skills for LMICs in stage 1 (factor-driven stage of development) are important; (ii)
countries will be increasingly required to turn their attention to labor and capital mobility and efficiency related issues as they
move toward stage 2 (efficiency-driven stage of development); and (iii) the same countries will be working toward facilitating
the establishment and use of business networks and innovation as they reach stage 3 (innovation-driven stage of
development).
2 Linked Document 3

Figure 1: Global Competitiveness Index

6
5
4
3
2
1
0
LIC LMIC UMIC HIC
Max Min

HIC = high-income country, LIC = low-income country, LMIC = lower

middle-income country, UMIC = upper middle-income country.
Source: World Economic Forum. 2015. The Global Competitiveness
Report, 2015–2016. Geneva.

4. Innovation. Technical and organizational innovations lead to changes in total factor

productivity and welfare benefits.6 The GCI adopts a somewhat narrow view of innovation, by focusing
largely on research and development and intellectual property aspects. This is consistent with the
traditional thinking that breakthroughs normally occur at the knowledge frontier. However, this misses
the point that innovation can also come from the ability to exploit new technological combinations,
and that such innovation need not entail massive expenditure on research and development.
Innovation is akin to knowledge production and can occur in developing countries.

5. The global innovation index (GII), which was launched in 2007, has attempted to find
approaches that better capture the richness of innovation in firms, governments, and societies.7 In so
doing, it appears GII is beginning to incorporate many aspects covered by GCI. This is particularly true
for those that relate to the basic prerequisites for innovation, referred to as the innovation input sub-
index in GII. This incorporates measures for institutional, infrastructure, human capital, research,
market sophistication, and business sophistication. It is interesting to note that GII also incorporates an
innovation output sub-index, which purports to capture: (i) knowledge generation, diffusion, and
impact; and (ii) creativity aspects. Some of these are intangibles, and some reflect the dawn of the
internet age.

6. Subject to reservations on the choice of indicators and proxies and measurement related
problems, the average GII for both low-income countries and MICs falls short of OECD countries (Figure
2). This is not surprising given the overlap between the variables that define GCI and GII. The Spearman
Rank Correlation between the two is also reasonably high at 70%.

6
National Bureau of Economic Research. 2001. New Volume in Productivity Analysis. University of Chicago Press: Cambridge,
MA. Chapter “Total Factor Productivity: A Short Biography” by Charles R. Hulten.
7
Cornell University, INSEAD, and the World Intellectual Property Organization. 2015. The Global Innovation Index 2015:
Effective Innovation Policies for Development. Geneva.
 Distinguishing Middle-Income Countries from Low-Income and High-Income Countries 3

Figure 2: Global Innovation Index

80

60

40

20

0
LIC LMIC UMIC HIC
Max Min

HIC = high-income country, LIC = low-income country, LMIC = lower

middle-income country, UMIC = upper middle-income country.
Source: Cornell University, INSEAD, and the World Intellectual Property
Organization. 2015. The Global Innovation Index 2015: Effective
Innovation Policies for Development. Geneva.

7. Change readiness. The change readiness index, which was designed on the premise that no
business or society is immune to change, tries to capture the capability of a country to anticipate,
prepare for, manage, and respond to a wide range of change drivers. It is structured around three
pillars: (i) government capability, i.e., the capability of governmental and public regulatory institutions;
(ii) enterprise capability, i.e., the capability of private and state-owned enterprises; and (iii) people and
civil society capability, i.e. individual, societal, and cultural determinants of capability. 8 The pillars
incorporate many indicators that are similar to those in GCI and GII. As for GCI and GII, OECD countries
score higher than MICs (Figure 3). The Spearman Rank Correlation between GCI and change readiness
index is close to 80%.

Figure 3: Change Readiness Index

1.0

0.8

0.6

0.4

0.2

0.0
LIC LMIC UMIC HIC
Max Min

HIC = high-income country, LIC = low-income country, LMIC = lower

middle-income country, UMIC = upper middle-income country.
Source: KPMG International and Oxford Economics. 2015. 2015 Change
Readiness Index. Helsinki. https://assets.kpmg.com/content/dam/
kpmg/pdf/2016/01/2015-change-readiness-index-v2.pdf

8. Doing business. The World Bank Group’s Doing Business Index is a measure of the quality and
efficiency of regulations that govern the setting up, functioning, and closure of domestic businesses. It
provides insights into understanding the extent to which government regulations can help create a
dynamic private sector that in turn generates profits, creates jobs, and provides tax revenue to the

8
KPMG International and Oxford Economics. 2015. 2015 Change Readiness Index: Assessing Countries’ Ability to Manage
Change and Cultivate Opportunity. https://assets.kpmg.com/content/dam/kpmg/pdf/2016/01/2015-change-readiness-index-
v2.pdf
4 Linked Document 3

government. By comparing Doing Business Index and its various sub-indexes across countries, the index
can provide insights into the type of measures that a government needs to take to encourage private
sector.

9. The 2016 index covers 189 countries, including 22 LMICs and 11 UMICs from Asia and the
Pacific region.9 To provide a better understanding of how these MICs compare with best practices
worldwide (the first ranked country in 2016 was Singapore), the distance-to-frontier is computed along
various dimensions.10 Figure 4 shows that, apart from the relative ease of starting a business in UMICs,
which is broadly in line with the global best practices, many UMICs have significant scope to improve
their business regulations for domestic firms. The gap is more pronounced for LMICs.

Figure 4: Doing Business Index

Starting business
100
Resolving insolvency 80 Getting electricity

60
40 Dealing with construction
Enforcing contracts
permits
20
0

Trading across borders Registering property

Paying taxes Getting credit

Protecting minority
investors
LMIC UMIC HIC
HIC = high-income country, LMIC = lower middle-income country, UMIC = upper middle-income country.
Sources: World Bank. 2016. Doing Business 2016: Measuring Regulatory Quality and Efficiency.
Washington, DC.

10. Governance. Governance is the manner in which power is exercised in the management of a
country’s economic and social resources, with the four key elements of good governance being
participation, predictability, transparency, and accountability. 11 Among the various important aspects
of governance is the budgetary process, which should be transparent and participative. The Open
Budget Index for 2015 covers 102 countries and compares budget transparency, opportunities for
public participation, and the strength of oversight institutions (the legislature and the apex audit
body).12 It attempts to capture the actual institutional practices in implementing policies and
regulations rather than what is mandated by law. The findings are reviewed by experts, and
governments are invited to review and comment on the findings and results. The results broadly show
that those countries assessed to be making sufficient budget information publicly available tend to
have higher income levels (Figure 5).

9
World Bank. 2016. Doing Business 2016: Measuring Regulatory Quality and Efficiency. Washington, DC.
10
The frontier represents the highest performance observed across all economies, on each of 10 sub-indexes. An economy’s
distance to the frontier is reflected on a scale from 0 to 100, where 0 represents the lowest performance and 100 represents
the frontier.
11
ADB. 1999. Governance: Sound Development Management. Manila.
12
International Budget Partnership. 2015. Open Budget Survey 2015: Open Budgets, Transform Lives. Washington, DC.
http://www.internationalbudget.org/opening-budgets/open-budget-initiative/open-budget-survey/
 Distinguishing Middle-Income Countries from Low-Income and High-Income Countries 5

Figure 5: Governance
Open Budget Index Corruption Perception Index
100 100
80 80
60 60
40 40
20 20
0 0
LIC LMIC UMIC HIC LIC LMIC UMIC HIC
Max Min Max Min

HIC = high income-country, LIC = low-income HIC = high-income country, LIC = low-income
country, LMIC = lower middle-income country, UMIC country, LMIC = lower middle-income country, UMIC
= upper middle-income country. = upper middle-income country.
Source: The International Partnership. 2015. Open Source: Transparency International. 2016. Corruption
Budget Survey 2015. Washington, DC. Perceptions Index 2015. Berlin.

11. Corruption is an important aspect of governance. The corruption perception index shows once
again that MICs as a whole lag behind OECD countries (Figure 5). This comes out even though there is
no meaningful way to assess absolute levels of corruption in countries on the basis of hard empirical
data. Such indexes have to rely on perceptions of corruption, simply because it is difficult or impossible
to find information that is normally deliberately hidden and comes to light only through scandals,
investigations, or prosecutions.13

12. Human development. The human development framework views development from a human
perspective. It emphasizes that the true aim of development is not just to boost incomes but also to
maximize choices available to people. The human development index assesses human well-being from a
broad perspective and takes into account the ability to (i) live long and healthy lives, as measured by
life expectancy at birth; (ii) acquire knowledge, as measured by mean and expected years of schooling;
and (iii) achieve a decent standard of living, as indicated by GNI per capita. 14 Figure 6 clearly shows that
MICs have some catching up to do.

13
The high score of HICs on the corruption perception index means they are less corrupt—the scoring system assigns a score of
zero to a country where the public sector is perceived as highly corrupt and 100 where it is perceived as very clean.
Transparency International. 2016. Corruption Perceptions Index 2015. Berlin. http://www.transparency.org/cpi2015
14
http://hdr.undp.org/en/content/human-development-index-hdi
6 Linked Document 3

Figure 6: Human Development Index

1.0

0.8

0.6

0.4

0.2

0.0
LIC LMIC UMIC HIC
Max Min
HIC = high-income country; LIC = low-income country; LMIC = lower
middle-income country; UMIC = upper middle-income country.
Source: United Nations Development Programme. 2016. Human
Development Report 2015. Washington, DC.

13. A broader set of indicators can be useful for gauging the extent of social inclusion. These may
include the extent to which a country has created an enabling environment for (i) providing high
quality education for all; (ii) creating jobs and improving labor force participation and decent working
conditions; (iii) supporting asset accumulation and production enhancing entrepreneurship; (iv)
channeling private savings for productive purposes; (v) allocating resources efficiently and supporting
competitive markets; (vi) investing in infrastructure and basic services to enable productive
engagement; and (vii) putting in place a tax system that countervails income inequality without
undermining economic growth. The World Economic Forum has attempted to compile data for such an
index, although it has been difficult to aggregate the data to arrive at a composite index value for each
country.15

14. Logistics performance. Good logistics means increasing supply-chain efficiency, which in turn
improves competitiveness in international trade and commerce. This has propelled logistics
performance to become a matter of public policy—although many logistics service providers are private
firms. The Logistics Performance Index (LPI) purports to compare logistics performance across countries,
and captures performance in four main areas: infrastructure, services, border procedures, and reliability
of the supply-chain. Figure 7 shows the generally better performance of OECD countries vis-à-vis MICs.

15
World Economic Forum. 2015. The Inclusive Growth and Development Report 2015: Insight Report. Geneva. See
http://www3.weforum.org/docs/Media/WEF_Inclusive_Growth.pdf
 Distinguishing Middle-Income Countries from Low-Income and High-Income Countries 7

Figure 7: Logistics Performance Index

5
4
3
2
1
0
LIC LMIC UMIC HIC
Max Min

HIC = high-income country, LIC = low-income country, LMIC = lower

middle-income country, UMIC = upper middle-income country.
Source: World Bank. 2016. Trade Logistics in the Global Economy: The
Logistics Performance Index and its Indicators. 2015. Washington, DC.

15. Environmental performance. The need to protect all types of ecosystems—terrestrial, fresh
water, and ocean—for sustainable development is now generally accepted.16 Additionally, it is
recognized that environmental degradation can have significant implications for human health.17 The
environmental performance index ranks countries by their performance on two areas—protection of
ecosystems and protection of human health. The ecosystem sub-index includes indicators for forests
and tree cover, agriculture, nitrogen use, water resources, wastewater treatment, biodiversity and
habitats, fish stocks, terrestrial and marine protected areas, and trends in carbon intensity. The human
health sub-index includes indicators for indoor and ambient air quality, access to drinking water and
sanitation, and associated health impacts from exposure to poor air and water quality.18 The findings
(Figure 8) show that OECD countries perform significantly better than MICs.

Figure 8: Environment Performance Index

100

80

60

40

20

0
LIC LMIC UMIC HIC
Max Min
HIC = high-income country, LIC = low-income country, LMIC = lower
middle-income country, UMIC = upper middle-income country.
Source: Yale University. 2015. Environmental Performance Index 2015:
Global Metrics for the Environment. New Haven.

16
An ecosystem refers to communities where biological organisms and species interact with the physical environment.
17
See www.ehhi.org. The Environment and Human Health, Inc. (EHHI) is dedicated to protecting human health from
environmental harm through research, education, and the promotion of sound public policy.
18
A. Hsu et al. 2016. 2016 Environmental Performance Index. New Haven, Connecticut. www.epi.yale.edu